Interest expense is an important term in the mortgage industry as your interest expense has a big impact on your payments and is also generally tax deductible. Interest expense is defined as the amount of your monthly mortgage payments that goes towards interest on your original loan. In the beginning of a 15 or 30 year fixed rate mortgage, your interest expense is usually higher, but it tends to decline as you pay down principle.
What Does Interest Expense Mean
When you take a mortgage loan, you pay interest on the money you borrow. The amount of interest you pay, or your interest expense, is determined by how much you borrow and by your interest rates. For example, if you take a $100,000 mortgage at a 6.5 percent interest rate, your interest expense if $6,500 per year.
Interest is usually calculated on a monthly basis for mortgages. This means that each month, you pay interest on the principle that you still owe on your mortgage. You can determine your monthly income expense by dividing your annual interest rate by 12. So, if your interest rate is 6.5 percent, you pay .005 percent per month. So, if you owe $100,000, you will pay around $500 per month in interest.
When you make your monthly mortgage payment, the payment is first allocated towards the interest that you pay. Any remaining balance goes towards paying down the principle. If you make an $800 payment, that means $500 will go towards interest and the remaining $300 will go towards reducing the total amount you owe on the loan. As your principle goes down, the amount of interest that you pay will gradually decrease since you are being charged 6% of a smaller number.
Knowing your interest expense is important so that you know how much of your money is actually going towards reducing what you owe. The higher the interest rate, the higher the interest expense and you will thus either have to make larger payments or take longer to pay off your loan.
Interest on a mortgage is normally tax deductible up to a certain percentage, depending on which tax bracket you are in. An account or real estate expert can you help you determine the appropriate tax deduction to take for the interest expense on your mortgage.
If you take an adjustable rate mortgage, your interest expense will adjust as interest rates adjust. If you have a fixed rate mortgage, your interest expense will remain more steady and will only change as you pay down principle.
If you take an interest only loan, on the other hand, your monthly payments cover only your interest expense. The principle remains the same and does not decline until you begin to pay enough each month to exceed your interest expense.
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